Quality compounders

ASML: shaping the future

ASML’s machines print the chips that power our everyday lives. It has quietly become Europe’s third most valuable company, and it keeps growing. Portfolio Manager William Nott talks us through why the business meets the threshold to be considered a quality stock.

May 10, 2024

4 minutes

Will Nott

The bedrock of digital life

Semiconductors power the smartphone in your pocket, the computer in your office, and the car in your driveway. It isn’t possible to live modern day life without them, and their importance keeps growing. As such, they're an exciting place to look for investments. However, semiconductors are a cyclical, volatile sector, with the potential for significant swings in supply and demand dynamics. Therefore, when we're looking for investments as quality investors – trying to find consistent sustainable compounding through the cycle – we look for businesses that are insulated from some of those risks. ASML is one such company.

ASML is a provider of semiconductor capital equipment. Essentially, they make the systems which make the chips. Importantly, they're focused on just one of the production steps in that journey: lithography. There are many hundreds of steps in the process to make a semiconductor chip, but the most important is lithography, which works a bit like a photocopier. A picture of a chip design is exposed to ultraviolet light and shone onto the surface of the silicon wafer. ASML is dominant here, with more than 70% share of the global market. More importantly, ASML is completely dominant in the next generation technology called extreme ultraviolet light, or EUV, lithography. EUV lithography is used to make the very smallest, most advanced chips available in the market today.

Three double-decker 747s

The technological barriers to entry here are extraordinary. When we look across our quality investment universe, we struggle to identify many, if any, companies that are as competitively advantaged as ASML. Much of that has to do with just how difficult it is to generate and harness EUV light. ASML spent more than two decades painstakingly developing and commercialising these systems, committing billions of euros to R&D along the way. One could argue they are the most complicated piece of equipment humankind has ever created. A single EUV unit takes more than 12 months to manufacture, costs in the region of 200 million euros, and takes three double-decker 747s to deliver it to a customer's site.

EUV light needs to be generated in a perfect vacuum. A high-powered laser fires a pulse of plasma 50,000 times a second at droplets of molten tin, the interaction of which generates the light. Via a series of highly engineered mirrors, that light is focused down to a single point to create the pattern on the silicon wafer. To contextualise how precise these mirrors are, if they were expanded to the size of Germany, the largest imperfection on their surface would be less than a millimetre tall. We struggle to identify any competitors that could replicate this level of technological innovation. Combine this with ASML’s entrenched relationship with the entire value chain and we think it's one of the most competitively advantaged businesses in the world.

Growing through cycles

ASML’s enviable position also helps to dampen the semiconductor industry’s inherent cyclicality. With roughly 70% share in the overall market and 100% of the most advanced systems, there are no competitors who could act irrationally through a downturn, distorting the industry. Secondly, the newest lithography machines are important strategic investments for customers, who are making purchase decisions many years in advance. As a result, ASML has a significant backlog of orders. As of the end of 2023, its order book stood at 39 billion euros, covering all their revenue for 2024 and most for 2025. This gives investors far greater visibility than the average semiconductor business.

A further driver of this visibility is ASML’s highly concentrated customer base – TSMC, Intel and Samsung account for about 80% of revenues. Usually, this would result in limited pricing power, however ASML has demonstrated the opposite over many decades. This is due to a long-standing commitment to sharing the benefits of innovation with those customers, helping them produce more chips at a lower cost. As a result, over the last decade, ASML has increased the average selling price on its systems at a high single-digit rate whilst keeping its customers happy. This symbiotic relationship between customer and supplier is another highly attractive element of its business model, which underpins our long-term conviction in the company.

Authored by

Will Nott
Portfolio Manager

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